SECURITY DEPOSITS - Understanding Commercial Leases - Part 8

This is Part 8 of a multi-part series on Understanding Commercial Leases

SECURITY DEPOSITS

PURPOSE - It serves as a mechanism for landlord to minimize likelihood they won’t get paid for rent, or for damage caused to the premises or landlord during term of lease

AMOUNT - It usually is based upon monthly rental rates. Typically it is equal to 1 or 2 month’s rent, but not always.

“LAST MONTH'S" RENT - Landlord’s should be careful to clarify, both in their leases and negotiations, that the security deposit is NOT the last month’s rent. Instead, it is a deposit that gets returned only after Tenant has met all lease obligations.

TAX TRAP - Deposits that are called “prepaid rent” or “last month’s rent”, are considered income at the time of collection and the Landlord will have to pay tax on it now, as opposed to later, if at all.

LANDLORD'S INTEREST

• Negotiate the largest deposit possible.
• Classify it is as deposit, not as prepaid rent, so as to avoid recognition for tax purposes
• Make sure the deposit is administered properly in accordance with state laws

TENANT'S INTEREST

• Negotiate the smallest deposit possible.
• Offer to pay prepaid rent, as opposed to a deposit, as this reduces the amount of
  “discretionary” money the landlord is holding and it makes sure the money that is being held gets applied to pay future rent obligations.
• Make sure landlord handles the deposit in accordance with state laws